Some regulators require construction or management audits to assess whether expenditures incurred in construction projects have been prudent and should be included in rate base. As a result of these audits or based on other factors, regulators may partially or totally disallow capitalized construction costs from rate base, cost-of-service recovery, or both. ASC 980-360-35 provides guidance on the accounting for disallowances of recently completed plants and requires loss recognition of any disallowed amounts on a dollar for dollar basis. This model is different from the impairment model under ASC 360, which requires a recoverability test and then measures impairments by comparing the carrying value of the utility plant to its fair value. Due to the differences in loss recognition under the two models, the determination of when the guidance in ASC 980-360-35 applies is important.

In accordance with ASC 980-360-35-12, when a regulated utility concludes it is probable that part of the cost of a recently completed plant will be disallowed for ratemaking purposes, and a reasonable estimate of the amount of the disallowance can be made, it should record such amount as a loss. In addition, a regulated utility may become aware of a disallowance prior to construction being completed, in which case the utility should recognize a loss at that time if the disallowance is probable. ASC 980-360-35-12 also requires recognition of a loss if part of the cost of a recently completed plant is explicitly but indirectly disallowed. An indirect disallowance occurs when, for example, no return or a reduced return on investment is permitted on all or a portion of the new plant for an extended period of time.

As discussed in ASC 980-360-55-29, to determine the loss resulting from an indirect disallowance, the regulated utility should first calculate the present value of the future revenue stream allowed by the regulator by discounting the expected future revenues using the last allowed rate of return. The utility should compare this amount to the recorded plant amount and record the difference as a loss. The utility should depreciate the remaining asset consistent with the ratemaking approach and in a manner that would produce a constant return on the undepreciated asset equal to the discount rate. Any subsequent changes in regulatory recovery should be recorded as an adjustment to the utility plant balance.

We have interpreted “recently completed plant” as utility plant, or an addition to utility plant, that has been placed in service but that has not been through an initial rate case. We do not believe the length of time between completion of the plant (or addition) and finalization of the rate case is a factor in the interpretation of what should be included within recently completed plant.

No. Prior to the codification, in the Basis for Conclusions of FAS 90, paragraph 63, the FASB considered requiring application of the loss recognition accounting to all cost disallowances by a regulator, whether related to recently completed plant or other situations. The FASB decided to limit the guidance on disallowances to the specific issues that caused it to add the project to its agenda (i.e., recently completed plant). See UP 18.7.3 for a discussion of other impairments of utility plant.

The fact that a regulator is unwilling to approve rates based on the current cost of service may call into question the basic premise of ASC 980. Specifically, ASC 980-360-35-13 and 35-14 indicate that when a regulator orders a disallowance without a specific finding as to excess capacity or timing of construction, the rate order raises questions as to whether the regulated utility is being regulated based on its own cost of service.

In our view, a plant disallowance is ordinarily an unusual, nonrecurring event and is only one factor to be considered in the continued application of ASC 980. Reporting entities faced with a disallowance of recently completed plant or other regulatory deferrals, such as a phase-in plan, should evaluate factors similar to those considered when recognizing regulatory assets (e.g., state regulatory history, cost forecasts, and the proposed length of the recovery period). The regulated utility should also consider whether it will recover substantially all of the carrying values of its assets and periodic operating costs through the regulatory process on an ongoing basis. See UP 17.2 for further discussion on the criteria for application of ASC 980.

ASC 980-360 includes specific guidance on accounting for abandoned utility plant and disallowances of recently completed plant. If a regulated utility has a potential impairment of utility plant that does not fall within the scope of ASC 980-360, it should follow the guidance for impairment of long-lived assets in ASC 360.

As described in UP 18.7.2, the distinction between a disallowance of recently completed plant and an impairment of utility plant in service is important due to differences in the models applied to recognize and measure any loss. In addition, long-lived assets that have been impaired in accordance with the guidance in ASC 360 may not be reestablished or written up in subsequent periods. The regulated utility should record any subsequent amounts allowed by the regulator through a specific rate action as a regulatory asset, if the criteria of ASC 980-340-25-1 are met.

Example UP 18-4 illustrates regulatory recovery of impairment costs.

EXAMPLE UP 18-4
Impairment analysis of plant

In March 20X1, Rosemary Electric & Gas Company’s regulator adopts a deregulation plan for the jurisdiction in which REG operates. As a result, REG determines that the generation portion of its business no longer qualifies for application of ASC 980. As part of the transition plan to competition, the regulator permits full recovery of the excess carrying value of REG’s generation plants above current market value as part of non-bypassable competition transition surcharge to all distribution customers. Assume the following:

How should REG record its regulatory recovery of impairment costs?

As part of the discontinuation of ASC 980, REG would perform an ASC 360 impairment analysis of its generation assets by comparing the carrying value to the market cash flows and determine that there is a $400 million impairment.

REG would record a loss on plant of $400 million, which is fully offset by a new competition transition charge regulatory asset.